Risk management
ING GROUP
ING GROUP RISK PROFILE
In 2007, ING Group made a significant step forward with its integrated risk management approach. At the Investor Day on 20 September 2007, the CRO presented for the first time the ING Group risk dashboard. This risk dashboard captures the risks in all Banking and Insurance business lines in terms of Earnings at Risk and Capital at Risk, and shows the impact of diversification across the Group. The Executive Board uses the risk dashboard to monitor and manage the actual risk profile in relation to the Group risk appetite. It enables the Executive Board to identify possible risk concentrations and to support strategic decision making. The risk dashboard is reported to the Executive Board on a quarterly basis and is subsequently presented to the Audit Committee.
ING Group’s risk appetite is defined by the Executive Board as part of the strategic planning process. Strict boundaries are established with regard to acceptable risk types and levels. ING’s ‘three lines of defence’ governance framework ensures that the risk appetite is cascaded through the Group, thereby safeguarding proper and controlled risk taking. The role of the business lines is to maximise the value within established risk boundaries. Each quarter, the Executive Board monitors that the financial and non financial risks are within the boundaries of the risk appetite as set in the strategic planning process.
ING Group risk metrics
The Group’s risk appetite is captured in three different metrics which are disclosed below:
- Earnings at Risk; the potential reduction in accounting earnings over the next year relative to expected accounting earnings, during a moderate (i.e. ‘1 in 10’) stress scenario. Maintaining a high quality of earnings safeguards against ING being downgraded by the rating agencies;
- Capital at Risk; the potential reduction of the current net asset value (based on fair values) balance sheet over the next year relative to the expected value during a moderate (i.e. ‘1 in 10’) stress scenario;
- Economic Capital; the amount of capital that is required to absorb unexpected losses in times of severe stress given ING Group’s ‘AA’ target rating.
ING Group’s risk metrics cover the most important aspects in terms of different severities (moderate vs. extreme stress) and performance measures where risk can materialise (value vs. earnings). The Earnings and Capital at Risk metrics are important metrics from a shareholder point of view since they provide insight in the level of risk ING takes under ‘moderate stress’ market expectations to generate return. From the debt and policy holder point of view, Economic Capital is more important since it is the buffer against extreme losses.
The main differences and similarities between the risk metrics are illustrated below;
| Earnings at Risk | Capital at Risk | Economic Capital | |
|---|---|---|---|
| Confidence interval | 90% | 90% | 99.95% (based on AA target rating) |
| Stressed metric | Accounting earnings | Value | Value |
| Deviation from | Expected accounting earnings (over next year) | Current net asset value based on fair values (over next year) | Current net asset value based on fair values (over next year) |
| Interpretation | Potential accounting earnings reduction against expectation during a ‘moderate’ stress scenario (i.e. 1 in 10) | Potential value reduction of net value during a ‘moderate’ stress scenario (i.e. 1 in 10) | Potential value reduction of net value during an ‘extreme’ stress scenario (i.e. 1 in 2000) |
When interpreting the Earnings and Capital at Risk metrics it is important to note that these are not loss estimates of a specific adverse scenario. Further, the metrics do not take into account discretionary management intervention in a specific crisis situation, and are based on instantaneous shock scenarios.
Risk types
ING’s risk profile measures the following main types of risks that are associated with its business activities:
- Credit risk: the risk of potential loss due to default by ING’s debtors (including bond issuers) or trading counterparties;
- Market risk: the risk of potential loss due to adverse movements in market variables, such as equity prices, real estate prices, interest rates and foreign exchange rates. These four market risks cover all market risks identified in ING’s businesses;
- Insurance risk: risks such as mortality, morbidity and property and casualty associated with the claims under insurance policies it issues/underwrites; specifically, the risk that premium rate levels and provisions are not sufficient to cover insurance claims.
Operational and business risk are summarised as non-financial risk in the risk profiles:
- Operational risk: the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events. It includes the risk of reputation loss;
- Business risk: the exposure to value loss due to fluctuations in volumes, margins and costs. These fluctuations can occur because of internal, industry, or wider market factors. It is the risk inherent to strategy decisions and internal efficiency.
The above risk metrics do not cover liquidity risk: the risk that ING or one of its subsidiaries cannot meet its financial liabilities when they fall due, at reasonable cost and in a timely manner. ING has a separate liquidity management framework in place to manage this risk. This framework is discussed in the ING Bank Liquidity Risk section below.
A description of the models, and underlying assumptions and key principles used by ING for calculating Earnings at Risk, Capital at Risk and Economic Capital is provided in the Model Disclosure section below.
Earnings at Risk
The level of Earnings at Risk (EaR) provides insight into the level of risk ING can absorb relative to its earnings power. The risk appetite set by the Executive Board defines the maximum potential reduction in accounting earnings over the next year during a (moderate, i.e. ‘1 in 10’) stress scenario as a percentage of forecast (pre tax) earnings over the next 12 months. Since ING does not disclose forecast earnings, the table below provides the Earnings at Risk per risk type compared to actual full year underlying earnings; i.e. underlying profit before tax. Under ING’s accounting policy, accounting results in the Taiwan Insurance business are currently used to strengthen the provision for life insurance. Future earnings may therefore be (partly) offset by increases/decreases to the cumulative reserve strengthening balance. The offsetting effect of increases/decreases to the cumulative reserve strengthening balance is not reflected in the earnings sensitivities below.
Earnings at Risk by risk type (Group diversified)
| Market | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2007 | Credit and Transfer | Interest Rate | Equity | Real Estate | FX | Insurance | Non financial | Total | Earnings 2007 | EaR/Earnings 2007 |
| ING Bank | 1,140 | 233 | 112 | 475 | 22 | 223 | 2,205 | 4,967 | 44% | |
| ING Insurance | 62 | 93 | 328 | 405 | 113 | 34 | 154 | 1,189 | 6,110 | 19% |
| Total ING Group | 1,202 | 326 | 440 | 880 | 135 | 34 | 377 | 3,394 | 11,077 | 31% |
Earnings at Risk by risk type (Group diversified)
| Market | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2006 | Credit and Transfer | Interest Rate | Equity | Real Estate | FX | Insurance | Non financial | Total | Earnings 2006 | EaR/Earnings 2006 |
| ING Bank | 1,226 | 288 | 49 | 274 | 21 | 251 | 2,109 | 5,052 | 42% | |
| ING Insurance | 107 | 79 | 100 | 378 | 146 | 44 | 160 | 1,014 | 4,807 | 21% |
| Total ING Group | 1,333 | 367 | 149 | 652 | 167 | 44 | 411 | 3,123 | 9,859 | 32% |
The ING Group EaR over the actual (pre-tax) earnings decreased from 32% in 2006 to 31% in 2007. This is primarily due to the earnings increasing stronger than EaR. ING Bank’s EaR dominates the overall ING Group EaR mainly due to credit and transfer risk. Furthermore, real estate risk combined for ING Bank and ING Insurance has a significant impact on EaR, especially when e.g. compared to interest rate risk. This is caused by the fact that, contrary to the accounting treatment of interest rate risk, most value changes in real estate assets directly impact earnings. The increase over 2007 in real estate risk for ING Bank was mainly due to a combination of an exposure increase in line with higher market values in 2007 (mainly in The Netherlands), and the introduction of improved risk modelling of business behaviour. The increase in equity risk for ING Bank was mainly caused by the inclusion of strategic equity interests, while the increase in ING Insurance is due to an increased earnings risk from potential equity impairments at year end 2007 and modelling refinements in Japan and US insurance entities.
An increase in credit risk (mainly Wholesale Banking) was more than compensated for by higher diversification benefits allocated to credit and transfer risk, leading to a slight decrease in 2007. The higher diversification benefit allocated to credit risk was a result of its reduced contribution to the overall risk profile, as real estate and equity risk grew much more relative to credit risk. In total, the overall diversification benefit between all major risk types remained stable in 2007.
Capital at Risk
The level of Capital at Risk (CaR) measured against ING’s financial position provides understanding as to whether ING can maintain a robust financial position under a ‘moderate’ (i.e. 1 in 10) stress scenario. The risk appetite set by the Executive Board defines the maximum potential value reduction over the next year during a (non extreme) stress scenario as a percentage of Available Financial Resources (AFR) (the definition of AFR is provided in the Capital Management section below). The tables below show the Capital at Risk per risk type.
Capital at Risk by risk type (Group diversified)
| Market | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2007 | Credit and Transfer | Interest Rate | Equity | Real Estate | FX | Insurance | Non financial | Total | Earnings 2007 | CaR/Earnings 2007 |
| ING Bank | 1,282 | 716 | 675 | 505 | 81 | 169 | 3,428 | 31,733 | 11% | |
| ING Insurance | 307 | 3,365 | 2,439 | 378 | 169 | 273 | 172 | 7,103 | 22,710 | 31% |
| Total ING Group | 1,589 | 4,081 | 3,114 | 883 | 250 | 273 | 341 | 10,531 | 49,715(1) | 21% |
(1) Total ING Group is comprised of ING Bank and ING Insurance, excluding core debt of EUR 4,728 million within ING Group.
Capital at Risk by risk type (Group diversified)
| Market | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2006 | Credit and Transfer | Interest Rate | Equity | Real Estate | FX | Insurance | Non financial | Total | Earnings 2006 | CaR/Earnings 2006 |
| ING Bank | 1,252 | 450 | 176 | 293 | 63 | 177 | 2,411 | 25,784 | 9% | |
| ING Insurance | 382 | 2,730 | 1,394 | 350 | 571 | 348 | 161 | 5,936 | 27,200 | 22% |
| Total ING Group | 1,634 | 3,180 | 1,570 | 643 | 634 | 348 | 338 | 8,347 | 48,774(1) | 17% |
(1) Total ING Group is comprised of ING Bank and ING Insurance, excluding core debt of EUR 4,210 million within ING Group.
The Capital at Risk figure tends to be dominated by ING insurance, mainly due to interest rate risk related to long-term client guarantees and equity risk.
The overall risk appetite for ING Group in 2007, measured as CaR/AFR, for ING Group increased to 21% (17% in 2006) as CaR increased more than AFR. This increase is mainly due to ING Insurance, where CaR grew while AFR decreased (for more information on AFR refer to the Capital Management section below).
The CaR figures show notable increases in equity and interest rate risks for both ING Bank and ING Insurance partly offset by a decrease in foreign exchange risk for ING Insurance. The decrease in foreign exchange risk within ING Insurance was largely due to a further alignment of business unit input with corporate aggregation in FX translation risk measurement and the positive impact of a US dollar hedge. The increase in equity risk in ING Bank is attributed to stakes in Bank of Beijing (IPO), the Indian Kotak Mahindra Bank and the TMB while ING Insurance’s increase is largely related to refined risk modelling at a unit level rather than changes in actual equity risk taking. In addition, the diversification at group level decreased due to higher equity risk concentration, lower interest rate risk netting between ING Bank and ING Insurance, particularly in Europe and Americas, and changes to risk aggregation parameters.
Capital at Risk and Earnings at Risk by line of business (Group diversified)
| 2007 | Earnings at Risk 2006 |
2007 | Capital at Risk 2006 |
|
|---|---|---|---|---|
| Wholesale Banking | 1,551 | 1,283 | 1,634 | 1,259 |
| Retail Banking | 438 | 542 | 939 | 592 |
| ING Direct | 158 | 259 | 566 | 503 |
| Corporate Line Bank | 58 | 25 | 289 | 57 |
| ING Bank | 2,205 | 2,109 | 3,428 | 2,411 |
| Insurance Americas | 430 | 281 | 2,022 | 1,346 |
| Insurance Asia/Pacific | 183 | 140 | 2,258 | 2,131 |
| Insurance Europe | 469 | 485 | 2,004 | 1,642 |
| Corporate Line Insurance | 107 | 108 | 819 | 817 |
| ING Insurance | 1,189 | 1,014 | 7,103 | 5,936 |
| ING Group | 3,394 | 3,123 | 10,531 | 8,347 |
During 2007 Group CaR increased more than Group EaR mainly due to the fact that CaR tends to grow faster than EaR under accounting rules e.g. the earnings impact for interest rates and equity price changes are normally lower than their economic impact.
For ING Bank, both CaR and EaR of Wholesale Banking increased as a result of higher credit and transfer risk and higher real estate risk. The increased Corporate Line Bank is mainly due to higher equity risk driven by recent acquisitions, e.g. TMB. For Retail Banking and ING Direct, the CaR in 2007 is higher, while EaR decreased compared to 2006. These differences are mostly driven by various enhanced modelling for amongst others credit risk, as well as the accounting asymmetries for equity and interest rate risk. Examples of this asymmetry include the increase in equity risk at Retail Banking due to the Bank of Beijing IPO, and different dynamics in interest rate risk netting between earnings and value. For earnings (EaR) ING Bank and Insurance exhibit similar interest rate risk sensitivities, while for value (CaR) ING Bank and ING Insurance sensitivities net each other. For ING Direct, the EaR decrease is also caused by a larger percentage of assets repricing within 1 year.
The increase in EaR for ING Insurance is mainly the result of increases in equity risk due to higher potential equity impairments and modelling refinements as mentioned in the EaR section above. The increase in CaR for ING Insurance is mostly driven by increased interest rate risk in the US as rates have decreased leading to higher risk related to guarantees embedded in liabilities, lower interest rate risk netting across the US and Europe, and higher equity risk in the US from the refined modelling.
Economic Capital ING Group
Since 1999 ING Bank has been disclosing Economic Capital information externally, whereas ING Insurance disclosed Economic Capital information for the first time in 2007. Although the fundamental principles are the same, ING Bank and ING Insurance Economic Capital information is currently calculated based on (partly) separately developed models (see Model Disclosure section below) that may differ in the calculation and aggregation approach due to different market practices and standards used in the banking and insurance industries.
ING’s Group Economic Capital and Bank-Insurance diversification benefit is determined by applying one common aggregation approach to bank and insurance. As a result, a best-estimate diversification benefit of approximately 15% for ING Bank and Insurance is applied for 2007 (2006: conservative estimate applied of 10%). Due to inherent uncertainties associated with correlation assumptions and changes in risk exposures the calculations are subjected to extensive sensitivity tests. Combining the 2007 reported ING Bank and ING Insurance Economic Capital figures and the above diversification benefits results in a combined Bank - Insurance Economic Capital of EUR 35.0 billion for 2007 (2006: EUR 34.5 billion based on 10% bank-insurance diversification benefit).
On the Group level an additional net risk capital estimate of EUR 1.0 billion (2006: EUR 1.0 billion) is added to reflect any Economic Capital specifically allocated to the Group, leading to a total Group Economic Capital amount of EUR 36.0 billion (2006: EUR 35.5 billion; see also the AFR/EC reconciliation in the Capital Management section below). The potential risk capital impact for ING Group of the ING employee pension liability is currently not included in the aggregated group risk metrics. However, the standalone Economic Capital impact for ING employee pension liabilities is calculated separately. From a capital management perspective there is currently no need to reserve any additional capital for ING pension liabilities.
Risk measurement ING Bank and ING Insurance
The overall ING Group risk appetite is translated into specific operational limits which are cascaded down into the organisation, e.g.
- Credit risk limits for bank and insurance business;
- Market Value at Risk limits for the insurance business;
- ALM/Value at Risk limits for bank operations.
The following risk disclosures provide more insight into how the risk measures used by the risk organisation are linked to the Group risk dashboard and Economic Capital.
